DP2079 Measuring Monetary Policy in Open Economies

Author(s): Fabio-Cesare Bagliano, Carlo A. Favero, Francesco Franco
Publication Date: February 1999
Keyword(s): Exchange Rates, implicit forward rate curve, Monetary Policy, VAR models
JEL(s): E44, E52, F41
Programme Areas: International Macroeconomics
Link to this Page: http://www.cepr.org/pubs/dps/DP2079

The empirical VAR literature on the monetary transmission mechanism in open economies has not yet provided a commonly accepted solution to the problem of simultaneity between interest rates and the exchange rate. In this paper we propose to solve the identification problem by using information extracted from financial markets independently from the VAR to measure monetary policy shocks. We also evaluate the relative importance of macroeconomic and monetary policy variables in explaining short-term fluctuations in the nominal exchange rate. Our main results are that the simultaneity between German policy rates and the US\ dollar/D Mark exchange rate is not an empirically relevant problem, and that monetary variables are dominated by macroeconomic factors in the explanation of exchange rate fluctuations.